Payout Choices

There’s no universal right answer about how to take your retirement plan payout, but when you have to make a decision, it helps to know the advantages — and the disadvantages — of your choices.

What the issues are

The level of comfort you have with making investment decisions is a major consideration in deciding among the various payout alternatives. If you’ve been investing successfully for years, the prospect of building a portfolio you control with a lump sum payout or an IRA rollover can be appealing — and realistic. Your challenge will be producing enough income during retirement.

But if you don’t want to worry about outliving your assets, you may opt for the relative security of an annuity. Knowing that the same amount is coming in on a regular basis makes budgeting — and occasionally splurging — a lot easier.

Periodic payments offer many of the same advantages as an annuity — minus the assurance that your income will last your lifetime. But if you feel you’ll need the bulk of your income in the early years of retirement, this could be the wise choice.

You’ll also want to weigh the amount you’ll owe in income tax. With a lump sum payout, you must pay the total that’s due at one time, which can substantially reduce the amount you have left to invest. With the other options, you owe federal income tax at your regular rate as you receive the money.

A close look at some important retirement choices:

Pension annuity

An annuity is a regular, monthly payment, usually for your lifetime.

Advantages

Option of spreading the payments out over your spouse’s lifetime as well as your own

Peace of mind in knowing you will have a steady flow of income

Disadvantages:

Fixed annuities not indexed for inflation, which means that your fixed income will buy less as time goes by. Variable annuities are designed to reflect market performance but produce less predictable returns

Income tax due on the amount you get each year

In most cases, an annuity choice is irrevocable and you can’t increase your payment or take a lump sum after payments begin

Plans could be terminated, leaving you with less than you expected or nothing at all

Periodic payments

Periodic payments are installment payments of roughly equal amounts paid over a specific period, often 5 to 15 years.

Advantages:

Assurance of a regular payment at regular intervals

Relatively large payments because of limited time frame

May be able to roll some but not all payments into an IRA

Disadvantages:

Commitment to payment schedule usually limits ability to get at lump sum, if needed

No assurance of lifetime income

Might leave yourself or spouse without funds after payments end

Large payments over a short time frame could push you into higher tax bracket, increasing the income tax you owe

Inflation can erode purchasing power of payments

Lump sum

A lump sum is a cash payment of the money in your retirement account.

Advantages:

Control over investing and gifting your assets

Not dependent on employer’s financial health

Disadvantages:

Tax due immediately on full amount of payment

Possibility of spending too much too quickly

Vulnerable to making poor investment decisions

No assurance of lifetime income

Might leave yourself or spouse without funds if assets are exhausted

IRA rollover

An IRA rollover is a lump sum payment deposited into an IRA account. You can either deposit it yourself or ask your employer to do it directly.

Advantages:

Money continues to be tax deferred

Allows you to invest as you want and take money as you need it

Allows you to postpone withdrawals and continue to build your asset base

Disadvantages:

Depending on your tax rate, you may pay more tax over time than you might have paid on the lump sum

Unless transfer made directly by employer, 20% of amount is withheld and must be deposited from other sources to avoid being taxed as a withdrawal

RMDs after 70 ½ from tax-deferred IRAs

Naming beneficiaries

At the time you’re making payout decisions, you may want to review the primary beneficiary you’ve named on your retirement account and perhaps choose a contingent beneficiary. That would ensure that the person you select would inherit the plan assets directly if you and your primary beneficiary were to die simultaneously.

In your corner

Perhaps you’ve lost track of a pension you’re owed from a job you left before you were eligible to retire. Perhaps the employer offering your defined benefit pension has ended its plan. In either case, you can turn to the Pension Benefit Guaranty Corporation (PBGC), a federal agency. If your plan ends, PBGC’s insurance program pays your benefit, though limits apply. And, if you’re owed a pension, PBGC is probably trying to find you.

Meeting minimums

One thing to keep in mind in choosing a payout method is what will happen when you reach 70 ½ and must take required minimum distributions (RMDs). If you’ve left your assets in your employer’s plan and have selected a lifetime annuity or periodic payments, the plan administrator is responsible for handling your income payments and ensuring that what you receive complies with RMD rules.

If you select an IRA, your custodian will calculate the account value at the end of each year, which is a key element in the formula you use to calculate RMDs. But you’re responsible for determining the required amount and withdrawing it.